Head of Fixed Income Strategy
Summary: Poor subscription at yesterday’s 4-week auction might be an early sign of liquidity strain. It is not a coincidence that T-bill auctions clearing with a yield close to or higher than 5.15% were better participated than those clearing with a lower yield. That’s the yield that the Federal Reserve pays on Bank Reserves. Therefore, bills must pay above 5.15% to be appealing for excess reserves at the Fed. If that's why the 4-week auction was poorly subscribed, the Fed has a problem. It means that money market funds alone will not be able to digest a large amount of debt coming to the market in the next three weeks. Therefore, bank reserves must pick up the slack, increasing the risk of a deposit flight, as we have seen in March. We will closely monitor next week’s auctions as the US Treasury prepares to sell nearly $300 billion in debt on Monday and Tuesday alone.
The US Treasury sold $329 billion in debt this week with little ado. Yet, it managed to raise only $50 billion in cash for the Treasury General Account, meaning the issuance bonanza has yet to start.
On Wednesday, the Treasury announced it aims to add $350 billion to its cash account in three weeks, making it one of the most extensive cash rebuilds it executed in such a short timeframe. To give some perspective, since the 2008 Global Financial Crisis, the US Treasury raised $116.5 billion a week under the TGA only eighteen times, 10 of which were during the Covid crisis.
It is worth noting that market conditions have changed profoundly since then: the fed fund rate is 500bps higher compared to the pandemic period and even double what it was at its highest since the GFC in 2019. Therefore, the debt issuance that will hit markets in the next three weeks might mop liquidity further in parts of the market where the Fed has failed to do so by hiking rates. A much less liquid market is vulnerable to volatility burst; hence, it would be reckless to dismiss such a tail even under current circumstances.
This week's 3-, 4- and 6-month T-bills saw solid demand with high bid-to-cover ratios and impressive indirect demand.
However, yesterday's 4-week T-Bill auction was surprisingly poorly subscribed. With a bid-to-cover of 2.49x, indirect bidders were at 39%, the lowest since May 2022. The auction tailed by 4.5bps clearing at 5.09% in yield. On the contrary, the 8-week T-bills issued on the same day received better demand, and the auction was able to stop through by 0.5bps, clearing at 5.12%.
The dissonance between earlier T-bills auctions this week and the ones of yesterday might lie within the yield that was offered. The 3-, 4- and 6-month T-bills were cleared with a high yield rate of 5.22%, 5.2%, and 5.25%, respectively. Yesterday’s 4- and 8-week auctions were cleared at 5.09% and 5.12%, respectively. Is it a coincidence that the T-Bill with the lowest yield has the poorest demand? It might, but it might eerily not.
Money market funds (MMFs) are paid 5.05% at the Reverse Repurchase Facility (RRP), while Bank Reserves at the Fed receive 5.15%. The only way that cash tight at both facilities is willing to buy T-bills is if they pay a higher yield than what the Fed offers. The fact that the auctions that offered more or close to 5.15% were better participated than those that offered a sensibly lower yield might indicate insufficient demand from MMFs to support debt issuance. Thus, bank reserves might be buying the bills.
We know that if MMFs at the Fed buy the bills, it won't be a problem for markets. If bank reserves buy the same, it might be a problem for Fed as another deposit flight could ensue.
Now, we cannot be sure of the above. Hence we will be closely watching next week's developments in the market as the Treasury ramps up T-bills sales trying to understand whether such a risk materializes.
Yesterday the Treasury announced next week’s debt sale volumes. Coupon sizes at next week's auctions are unchanged. Only the 52-week T-bill has been upped by $2 billion to $38 billion. The new 6-week bill size is chunky at $45 billion. Between Monday and Tuesday, the Treasury plans to sell almost $300 billion in debt in two days. Yet, it must confirm the sizes for the auctions on Wednesday and Thursday.
We will closely monitor next week's auctions to understand whether the liquidity drain might be a catalyst for something bigger in markets.
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